We examine the impact of Chinese import competition on patenting, IT, R&D and TFP using a panel
of up to half a million firms over 1996-2007 across twelve European countries. We correct for endogeneity
using the removal of product-specific quotas following China’s entry into the World Trade Organization.
Chinese import competition had two effects: first, it led to increases in R&D, patenting, IT and TFP
within firms; and second it reallocated employment between firms towards more innovative and technologically
advanced firms. These within and between effects were about equal in magnitude, and appear to account
for around 15% of European technology upgrading between 2000-2007. Rising Chinese import competition
also led to falls in employment, profits, prices and the skill share. By contrast, import competition
from developed countries had no effect on innovation. We develop a simple “trapped factor” model
of innovation that is consistent with these empirical findings.